How much money should you spend on marketing? Is there a good rule of thumb? Is it 2% of revenue? 5%? Should it vary based on your industry specialties? Digital marketing further complicates the equation since we have data available on everything we do online. What’s important and what’s not? Instead of simply choosing a percentage based on conventional wisdom, this article will show you three simple calculations to use when you’re trying to determine how much money your company should spend on marketing.
Calculating the Average Close Rate
Look at your last four quarters of lead conversion. Said another way, how many of your prospects became clients over the past year? As this article is being written, it’s the beginning of April, so if you’re like most businesses, your 1st quarter just ended on March 31. Regardless, start with the most recent data available from the most recent quarter. Here’s a sample of what you should write down:
1st Quarter (March 31): 4 clients and 23 total prospects = 17.4% closing rate
“Wait a minute,” you might be thinking, “During that quarter, some prospects were added the last week of the quarter, while some were there for months.” Don't worry about the timing of the clients and the prospects right now. It’s important, in using these calculations, that you just consider the 1st quarter numbers all on their own. If you get too complicated with these calculations, they'll get overwhelming. We're not doing a full analysis of your company’s sales cycle. Just ask yourself, “During this period of time, how many prospects became clients, and how many additional prospects did we add to our list?” For purposes of determining our marketing budget, we use our average closing rate. Here’s a sample of what this could look like over four quarters:
Q1 (March 31): 4 clients and 23 total prospects = 17.4% closing rate
Q2 (June 30): 3 clients and 32 total prospects = 9.4% closing rate
Q3 (Sept. 30): 2 clients and 27 total prospects = 11.1% closing rate
Q4 (Dec. 31): 8 clients and 19 total prospects = 42.1% closing rate
Average closing rate over one year (four quarters) = 16.8% (17 clients from 101 total prospects)
Notice how the closing rate was dramatically higher in the 4th quarter? This is indicative of a typical retirement plan-focused advisory/consultancy, so it’s important we have at least four quarters of data to accommodate this fact.
Now that we know how many of our prospects become clients (16.8% of them), how much revenue did these 17 new clients from the past year generate?
Calculating Client Current Value
For purposes of this sample, let’s say the 17 new clients spent a total of $94,308. This means that each client’s current value to your company is $5,547.53. Each prospect, then, is worth $933.74 of revenue. Since we don’t know which of our prospects will become clients, it’s important to pay attention to both numbers.
Now we just need to determine the profit per client and prospect. In this sample, we'll say your company’s profit margin is 38%. The profit per client, then, is $2,108.06 ($5,547.53*.38), and the profit per prospect is $354.82 ($933.74*.38). A lot of companies—if they get this far at all—stop at this point. They say, “If we’re making a profit from each prospect, then we’re okay.” They then estimate that they can spend anywhere between $0 and $354.81 (literally one penny of profit) on marketing to each prospect.
This is fine if you’re running a one-and-done business. If you’re going door to door selling candy bars as part of a fundraiser or renting umbrellas on the beach to tourists on a sunny day, this might be a good approach. However, I’m guessing you’re not in that situation. You want to earn the business of clients that stay clients. This next calculation will help you dramatically outperform your competition.
Calculating Client Lifetime Value
Client lifetime value is the most important number that most companies don’t consider. Look back over your historical records. How long do clients typically stay clients? Three years? Eleven years? Let’s say for this sample company, the typical time period is seven years. If we look back over this period and build a profile, here’s what we find:
Average client duration: seven years
Spends $38,832.71 with our company
Based on current profit margins, this client is worth $14,756.43 of profit
Why is this so important? Have you ever looked at a company and said to yourself, “How are they spending this much money on marketing?” Amazon famously did this when founder Jeff Bezos told his sales staff they could spend $33 per new customer, even if that person only bought something for $1. Starbucks spends enormous amounts of money on each new location, based on their calculated customer lifetime value. You can use the same strategy these famous brands do.
How Much Should You Spend on Marketing?
The answer is: it depends. Using these calculations will give you much, much more confidence when it comes to your budget, instead of simply allocating 2% or 5% of gross revenue to marketing. Based on the sample company numbers we’re using, if each client is not just worth $5,547.53 (the current amount) but worth $38,832.71 (the lifetime value), do you see why the sample company can justify spending more money on marketing using the lifetime value approach? What about in your case? What is the lifetime value of your clients?
I’ve seen many companies—after doing these calculations—say, “We realize now we don't need to generate a profit the first year of a client relationship. Since our clients stay with us seven years on average, the profit will come.” Without this pressure of first-year profits, you can be more selective when choosing new clients. If you do this homework, you can confidently spend more marketing money (and time) attracting the clients you really want. Instead of looking at current value alone, be sure you determine the value of that relationship in its entirety.
Spencer X Smith is the founder of AmpliPhi Social Media Strategies. He’s a former 401(k) wholesaler, and now teaches financial services professionals how to use social media for business development. This column originally appeared in the Summer issue of NAPA Net the Magazine.